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Schlumberger Stock Upgraded: What You Need to Know

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

At 21.4 times earnings today, the S&P 500 isn't as expensive as it's been in recent years. Still, it's trading well above its long-term average P/E, and bargains remain hard to find.

But Stifel Nicolaus believes it's found one: Schlumberger (NYSE: SLB).

Five dice labeled buy and sell on top of LCD screen displaying charts and numbers

Image source: Getty Images.

What you need to know

This morning, the St. Louis-based boutique investment banker announced it's upgrading shares of oil and gas services giant Schlumberger to buy from hold while holding firm on its $50 target price.

Why? Thanks largely, if not entirely, to a recent drop in the price of oil, Schlumberger stock has been crushed, and is trading today for half-off its share price of just one year ago. At today's prices, Stifel sees three strong reasons to buy the stock.

Let's review them.

"Compelling" valuation

Stifel says there's a "compelling risk/reward" to investing in Schlumberger stock "at current levels" -- a rather bold statement, but not, I think, unreasonable. Consider: At its current share price of $35 and change, Schlumberger stock has a market capitalization of $49.1 billion. Add $14.4 billion in net debt on the balance sheet, and the company's actual enterprise value rises to $63.5 billion.

Now, after two straight years of losing money, Schlumberger turned profitable again last year, and remains so today. Still, with only $2 billion in trailing profits, that works out to a rather steep P/E ratio of 24.6, and an even steeper debt-adjusted P/E of 31.8.

How could numbers this high look "compelling" to Stifel? Well, consider this: According to analysts polled by S&P Global Market Intelligence, Schlumberger's earnings are going to grow steadily over the next five years. Already, 2019 earnings are projected to eke out a small rise over the $1.53 per share the company earned last year -- then shoot up 43% in 2020, and keep on increasing all the way through 2022 at least. That year, analysts forecast Schlumberger will earn $4 a share -- 261% of what it earned in 2018 -- making for a compound annual earnings growth rate of more than 36%.

Suffice it to say that a 36% growth rate can make even a debt-adjusted P/E ratio of 32 look cheap.

"Solid" free cash flow

And this story gets even better. Not only is Schlumberger profitable again, you see, but Stifel says it has "solid free cash generation" as well. S&P Global data shows that its free cash flow over the past year approached $2.5 billion -- more than 20% above reported net income of $2 billion.

Looked at from this perspective, Schlumberger stock sells for an enterprise value (essentially the same thing as its debt-adjusted market cap) of only 25.4 times its free cash flow. Relative to the projected growth rate, that makes shares look like an even better bargain.

A "safe" dividend for your portfolio

Granted, oil prices are diving right now, and oil stockpiles are growing -- indicative of weak demand for dinosaur juice, which logically would translate into weak demand for the kind of oil-field services Schlumberger provides to its oil-drilling clients. This could certainly postpone the growth that analysts are forecasting for the company.

But experience has taught us that oil is a cyclical industry, and has been so for decades. Low oil prices always beget high oil prices later on, as underinvestment results in too little supply to meet demand down the road. And yes, the reverse is also true. But that still means that the lower oil prices we are seeing today should give way to higher oil prices, higher oil demand, and higher demand for Schlumberger's services -- eventually.

This leads us to Stifel's third reason for recommending Schlumberger stock today: The company's generous 5.7% dividend yield essentially pays investors to wait until the promised profits of $4 roll around in 2022. At that point, Schlumberger's shares should look so cheap that investors won't be able to help but buy them.

Which is why Stifel recommends you buy the stock today, before its price goes up.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.